Red Book Flashcards
What is the basic accounting formula?
A=L+E
What does equity consist of?
Retained earning, Preferred stock, Common Stock, Treasury Stock, Accumulated Other Comprehensive Income.
What does common stock consist of?
Par and APIC
What does RE consist of?
Net Income and Dividends
What type of dividends can there be?
Cash, Property, Stock.
What is the normal balance for SE? What are some exceptions?
SE has a “normal” credit balance, there are some SE elements that will be debits (such as treasury stock, a contra equity account)
A share of stock gives (or may give) the holder the right to:
- Dividends (but only if declared)
- Right to vote for the Board of Directors (usually true for common shares, but usually not true for preferred shares)
- Assets upon liquidation–though preferred shareholders “stand behind” creditors, common shareholders stand behind preferred shareholders. (So common shareholders may get nothing in a bankruptcy)
What increases and what decreases retained earnings?
Net income increases REs and dividends decrease REs.
While retained earnings reflect realized income, AOCI reflects certain:
Unrealized gains and losses (such as those arising from holding available for sale securities)
What is a JE if a company issues 1,000 shares of CS for $10 per share, $1 par?
DR: Cash 10,000
CR: Common stock 1,000 (shares x $1 par)
CR: APIC- CS 9,000 (plug)
Stock issuance costs are an expense?
Paying outside parties for underwriting, legal, and accounting are not an expense. Instead, they reduce the proceeds from sale/issuance of the stock.
DR: APIC
CR: Cash
What value is used if stock is issued for a non cash asset?
For example is you get Land, record the land at at the FV of the land or the FV of the stock, whichever is more clearly determinable.
Issuing stock to a non employee for outside services (such as in return for legal or consulting services) follows what principle?
same as issuing stock in return for a non cash asset:
Use the FV of the outside services or the FV of the stock, whichever is more clearly determinable.
What if CS and Preferred stock is issued at the same time- how are they allocated?
A lump sum recieved is allocated in proportion to the FVs of the stock issues.
What is a stock subscription and how is it recorded?
Is when the company may enter in to a contract to issues stock. In this case, a cash down payment is received, and the company hold a receivable for the remaining issuance amount. This receivable is no ordinary receivable (not an asset)- it’s a contra equity account.
DR: Cash
DR: Stock subscription receivable
CR: CS subscrited
CR: APIC CS
What is a JE when you issue stock rights?
What is the JE when you exercise rights?
When issue rights: No JE. only a memo entry is made when rights are issued because the rights are issued for zero consideration.
When the rights are exercised:
DR: Cash 20,000
CR: CS 5,000
CR: APIC CS 15,000
What is a treasury stock?
When a company buys back its own shares.
What are the two acceptable alternatives to account for treaury stock?
- Cost method
- Par Value method
What are the 4 gotta know points regarding treasury stock?
- No gain or loss (when a co transacts its own shares, never record G or L)
- TS is not an asset (it’s a contra asset)
- TS is still “issued” stock (while no longer outstanding stock, TS remains “issued” shares)
- Cost and par value have same effect on total SE
What are the JE for Cost method?
June: Boomer co issued 100 shares of CS for $13/share. Par $10
July: Bommer bought back 20 shares at $14/share
August: Bommer reissued 10 of the treasury shares, at $16/share
Sep: Boomer reissued 10 of the treasury shares at $11/share
June
DR:Cash 1,300
CR: CS 1,000
CR: APIC-CS 300
July
DR: Treasury Stock 280
CR: Cash 280
August
DR: Cash 160
CR: Treasury stock 140
CR: APIC TS 20
September
DR: Cash 110
DR: APIC TS 20
DR: Retained earnings 10
CR: Treasury stock 140
What are the JE for Par Value?
June: Boomer co issued 100 shares of CS for $13/share. Par $10
July: Bommer bought back 20 shares ar $14/share
August: Bommer reissued 10 of the treasury shares, at $16/share
Sep: Boomer reissued 10 of the treasury shares at $11/share
June
DR:Cash 1,300
CR: CS 1,000
CR: APIC-CS 300
July
DR: Treasury Stock 200
DR: APIC CS 60
DR: Retained earnings 20
CR: Cash 280
August
DR: Cash 160
CR: Treasury stock 100
CR: APIC CS 60
September
DR: Cash 110
CR: Treasury stock 100
CR: APIC CS 10
What is cumulative preferred stock?
If PS is cumulative, and dividends are not paid for one or more periods, they are dividends in arrears. Dividends in arrears are not a liability but must be disclosed. All PS dividends in arrears (and also current year PS dividends) must be paid before common shareholders get a dime.
All dividends reduce:
Retained earnings.
One exception- liquidating dividend
What happens on declaration date, record date, and distributions date of the dividend?
Declaration date: Once the Board declares a dividend, RE is debited and it becomes a liability
Record date: This is the date on which it’s determined exactly who will receive the dividend. If a shareholder sold his stock before the date of record, he doesn’t get a dividend. There is no JE on the record date.
Payment/Distribution date: This is the date the cash is paid, or the property or sotck is distributed.
The accounting for stock dividends differs depending on whether it’s:
A small or large stock dividend.
What are the JEs for cash dividend?
Cash dividend declared:
DR: RE 60,000
CR: Dividend payable 60,000 (Liability)
Date of record:
No JE
Payment date
DR: Dividend payble 60,000
CR: Cash 60,000
Property dividends are recorded at what?
At Fair Value. Adjust the property to FV by recording a gain or loss for the difference between the book/carrying amount and FV.
DR: Investment in Spence
CR: Gain
What are the JEs for Property dividend if book value was $200,000 and FV was $300,000?
Step 1: Adjust the Spence stock to FV. (300-200=100 gain)
DR: Investment in Spence 100,000
CR: Gain 100,000
Step 2: Record the dividend at FV
DR: RE 300,000
CR: Property div distributable 300,000 (liability)
Date of record:
No JE
Distribution Date:
DR: Property div distributable 300,000
CR: Investment in Spence 300,000
A key point for stock dividends is that there is no change in:
Stockholder’s equity.
What is considered small dividend and large dividend?
Small=less than 20-25%
Large= more than 20-25%
What values of shares are to be used for small stock dividends and large stock dividends?
Small- FV
Large- Par
What are the JEs for small stock dividends on the date of declaration and date of distribution? FV 12$, par value $1, shares 10,000
Date of declaration:
DR: RE 12,000
CR: CS div distributable 1,000 (Equity account)
CR: APIC CS 11,000
Date of distribution:
DR: CS div distributable 1,000
CR: CS 1.000
What are the JEs for large stock dividends on the date of declaration and date of distribution? FV 12$, par value $1, shares 10,000
Date of declaration:
DR: RE 4,000
CR: CS div distributable 4,000 (is an equity account)
Date of distribution:
DR: CS div distributable 4,000
CR: CS 4,000
CS dividend distributable in stock dividends, is what kind of account?
Equity account
What happens if a company has lots of cash and wants to pay a dividend, but has no retained earnings?
A possibility is to declare a liquidating dividend.
A liquidating dividned is a return of?
Capital, not a return on capital. It reduces APIC.
What is the JE for a liquidating dividned: declares a dividend of $500,000, when RE is only $100,000. The APIC balance is $2,000,000.
DR: RE 100,000
DR: APIC 400,000
CR: Dividend payable 500,000
What is a scrip dividend?
A scrip dividend is a promise to pay a cash dividend to the shareholders at a later date-a company’s IOU to the stockholders. The shareholders , for their patience, are also paid interest– so a scrip dividend payable behaves like a note payable.
What are the JE for scrip dividend when declared and when paid?
Scrip dividend declared:
DR: RE
CR: Scrip div payable
Scrip dividned paid:
DR: Scrip div payable
DR: Interest expense
CR: Cash
If a company has both preferred and common stock, and the PS is cumulative (but not participating), what are the 3 steps to allocate?
- Pay PS dividends in arrears
- Pay current year preferred dividend
- The rest of the bucket (remaining dividend) goes to common shareholders.
If a company has both preferred and common stock, and the PS is cumulative and participating, what are the 4 steps to allocate?
- Pay PS dividend in arrears
- Pay current year preferred dividend
- Give the preferred dividend % to the common shareholders (pfd% x common par)
- Allocate remaining dividend to preferred and common in proportion to total par value of each.
What is dividend payout ratio?
Dividend payout ratio is the portion (percentage) on income paid out to shareholders. A company’s board of directors will often try to keep the payout ratio fairly steady from year to year, though this may not always be possible if income spikes up or plummets down.
What is payout ratio formula?
Total cash dividends declared on common/(net income - pfd dividneds)= DPS/EPS
What is the dividend yield formula?
Dividend/market price=dividend yield
Why may a company split its stock?
If it believes the market price appears too high. For an accountant at a company, (and for that matter, the company’s auditor), this is as easy as it gets- becuase there is no JE. Therefore there is NO effect on SE accounts.
What happens in a stock split?
- Par value per share decreases
- # shares outstanding increases
How is RE calculated?
Beginning balance
plus Net Income
Less Dividends
Ending balance
What is a quasi- reorganization?
If a company has a REs deficit (debit balance), and may also have overstated asset values, it can undergo (with shareholder and creditor approval) a “fresh start” quasi- reorganization (Q-R). The Q-R will eliminate the RE deficit- the new RE balance will be exactly zero. APIC (contributed capital) is used to absorb the RE deficit.
What are the steps in Q-R?
- Record assets at FV, which probably means a write down of assets. Note that this will actually make the RE deficit even larger, but this is all part of the “fresh start.”
- If there is not enough APIC to absorb the deficit, create additional APIC by reducing the par value of stock (par value per share is reduced, to an even amount.)
- APIC is used to absorb (eliminate) the RE deficit. New RE balance=$0
What is Accumulated Other Comprehensive Income?
AOCI results from changes to SE other than contributed capital (investments by owners) and REs. While REs reflect realized income, AOCI reflects certain unrealized gains and losses related to:
- AFS investment securities
- Derivatives accounted for as cash flow hedges
- Foreign currency translation adjustments
- Pension adjustments related to prior service cost and actuarial gains/losses
What is OCI?
What is AOCI?
What is CI?
OCI (other comprehensive income)= unrealized gains or losses for a period
AOCI (accumulated OCI)= unrealized g/l going into the account and realized g/l coming out. A balance sheet account
CI (comprehensive income)= Net Income+OCI. So CI represents both realized income and unrealized income that by - passed the income statement
The presentation of comprehensive income can be handled in either of 2 ways:
Continuous statement-OCI “tacked on” to the bottom of the income statement; a ‘regular’ full IS, then at the bottom add OCI to get CI.
Separate statement- its own statement shown after the IS; start with NI and add OCI to get to CI, basically as shown in the box above (but with different OCI items each on their own line).
What is ROE?
Return on equity= how much income is generated for each dollar invested.
What is the formula for ROE?
Net income - Preferred dividends
Average common SE
What is a stock option?
This type of option give an employee the right to purchase a share at a fixed price (called the exercise price), over a fixed time period. The fixed time period over which the option is exercisable typically begins once the service period (vesting period) is complete.
When a company grants a stock option to an employee, the company should record:
Compensation expense related to the grant date FV of the option. Compensation expense is spread evenly (SL) over the required serivice period.
What is Black Scholes and what 6 inputs are taken into consideration?
Option pricing model
- Exercise price
- Current price of the underlying share
- Expected volatility of the stock price
- Expected term of the option, taking into account the expected vesting, post-vesting, and employee termination behaviors.
- Risk free interest rate for the expected term of the option
- Expected dividends on the underlying stock.
So what is the general rule for stock options?
Expense the grant date FV over the service period. Know this rule! If no service period is required (e.g., if no options are granted in recognition of past service), then expense the options immediately.
What is the entry to record compensation expense?
DR: Comp expense
CR: PIC-SO
*has no effect on total SE*
Dividends in arrears are a liability? True?
No, not a liability, but must be disclosed.
